Price-Fixing Case Against Apple, Major Book Publishers Mushrooms

Back in August, a class action lawsuit was filed against five major book publishers and Apple (NSDQ: AAPL), accusing them of colluding to jack up the price of e-books in an effort to wrest back pricing power from Amazon (NSDQ: AMZN). The suit claims millions of customers overpaid for e-books because of the alleged price fixing plan.

Turns out, that suit was simply the opening act. It has now ballooned into more than a dozen lawsuits, and dragged Amazon and Barnes & Noble (NYSE: BKS) into the mix.

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The very next day after the original suit was filed in California, a New York firm pounced on the publishers with a second lawsuit — and 15 others soon followed, according to plaintiffs’ attorney, Douglas Thompson. A lawyer for the publishing industry who did not want to be identified says Amazon has been named as a defendant in at least two of the lawsuits and Barnes & Noble in one of them.

At the heart of the flurry of lawsuits is a challenge to “agency pricing,” the e-book pricing model under which book publishers set their own prices for e-books, paying the e-tailer (“agent”) a commission. Agency pricing requires e-books to be priced the same across all e-bookstores, meaning an e-tailer like Amazon can’t put a book from a participating publisher on sale to gain an edge over a competing seller — only the publisher can do that; and if an e-book goes on sale at one e-bookstore, it has to be priced the same at all others.

Currently, the “big six” book publishers–Hachette, HarperCollins, Simon & Schuster (NYSE: CBS), Macmillan, Penguin and Random House–are the only U.S. publishers using the agency pricing model. Other publishers are still using the wholesale model, under which they set an e-book’s list price but the etailer can charge whatever it wants (and can sell an e-book at a loss). Hachette, HarperCollins, Simon & Schuster, Macmillan and Penguin all adopted agency pricing in January 2010 as part of negotiations with Apple prior to the launch of the iPad. After some skirmishes, Amazon capitulated and agreed to the agency model as well. Random House did not adopt the agency pricing model until March of this year, and was not included in the original class-action suit, although it is listed in the New York suit filed the next day.

Book publishers see agency pricing as vital to taking back control from retailers in the pricing of e-books. Complaints about Amazon’s e-book pricing stemmed from the fact that Amazon was marking down new bestsellers ($9.99 for Kindle versions of all New York Times (NYSE: NYT) bestsellers and many other new titles) to make them cheaper than print books–not just cheaper than hardcovers but also paperbacks. Fearing that e-book sales would cut into their print sales (and that everyone would opt to buy cheap e-books over more expensive hardcovers), publishers sought a way to sell release new titles as hardcovers and e-books simultaneously, while still maintaining some control on pricing. In fact, in the nearly two years that agency model has been operative model, publishers have used it to do just that.

E-books now account for at least 15 percent of revenues for most big book publishers, and digital sales are growing much faster than print sales. Because the publishers are guarded with their numbers, it’s unclear how much of that growth is due to the fact that consumers are buying more e-books in general, and how much is due to this increased control over pricing. Many readers believe that e-books should be cheap because they involve none of the printing costs that paper books do. Publishers argue that most of the costs of publishing a book are fixed (acquisition, cover design, editing, marketing, etc), and don’t go away in a digital world. Currently, customers generally pay a couple dollars more for an e-book than they would have when Amazon controlled pricing. Under agency pricing, publishers can still put their e-books on sale, and are doing so more than they did, say, a year ago.

The new scale of the litigation ensures that agency pricing will be an ongoing source of controversy in 2012 as the book-publishing industry looks to the swelling e-book market for future revenues.

The various cases are on hold for now as the law firms wrangle about where the litigation should take place. The lawyers have asked a special panel — called the Judicial Panel for Multidistrict Litigation — to consolidate the cases and to choose a venue for them. That’s an unusual move that is reserved for cases that are particularly important or complex, like the BP oil spill. The panel of judges would then assign the consolidated case to a single judge to manage.

Thompson, the lawyer who filed the initial New York case, hopes the panel will agree to consolidation and choose Manhattan as the venue. He says that the judges may side with others who want the case heard in San Francisco, or the judges could choose another venue altogether. But he believes this is unlikely. “It’s a publishing case, and Manhattan is the center of publishing in this country.”

The publishers and their tech giants allies are heading into new legal territory with agency pricing. That is because owners’ power to set prices changed considerably following a 2007 Supreme Court case called Leegin. Prior to Leegin, which involved a handbag maker, it had been an automatic violation of antitrust law for manufacturers to impose prices on retailers. But the Supreme Court decided to reject this rule, which had been in place for nearly 100 years, in favor of a more flexible case-by-case approach that is based on whether or not it is reasonable for a manufacturer to impose a fixed price. The fight over e-books will likely be decided on this basis.

“It’s a similar situation to Leegin,” said Andre Barlow, an anti-trust lawyer in Washington. “The publishers can be viewed as manufacturers in this case.”

That does not necessarily mean they will succeed, however. The handful of so-called “vertical price-fixing” have produced mixed results — a California court found a cosmetic maker’s price controls illegal under state law, while a New York court said that “resale price maintenance” was acceptable for Tempur-Pedic mattresses.

To prevail, the publishers will have to persuade a court that their pricing scheme is reasonable. They may argue that it is on the grounds that the alternative was destroying their business.

“They can’t just cry, ‘we’re losing business’,” said Barbara Sicalides, an anti-trust expert at Pepper Hamilton. She says publishers and Apple will likely have to produce sensitive business records to prove that the agency pricing model is ultimately necessary to protect consumers.

Nothing is going to happen anytime soon in the case. The panel of judges is not meeting until December and will likely take weeks to issue a decision about venue. But the arrival of the Kindle Fire and the robust growth of the e-book market means there will be even more at stake when (and if) the class action suits go to trial.

As long as the wholesale pricing actually is wholesale pricingâ€”as in, the retailers are paying publishers a specific amount per e-book sold no matter what the retailer price isâ€”I have no problem with wholesaler pricing.Â I actually prefer its precedent to agency pricing, but I fear that the wholesale pricing scheme would end up modified if forced upon retailers, with retailers only paying content providers a percentage of whatever retail price the retailers choose.

The big publishing houses are very shortsighted. They don’t seem to realize that their real competition in today’s market comes from the sale of used books whichÂ are very cheap and easy to find and buy on the Internet. Why don’t they realize that when people feel that the price of an ebook is too high that they will buy a used print book instead?Â
I suspect that very soon most authors will self-publish ebooks and hire the professionals they need, like editors, to help them. When that happens, it will be another nail in the coffin of the traditional publishing houses.Â I laugh when they say that the cost of producing ebooks is the same as print books ignoring the cost of paper and shipping while pointing out the cost of things like cover designs. How many ebooks have cover designs? Maybe half of those I’ve read. How many ebooks include photos? Very few so far but I suspect and hope that changes soon. Â Â
Unless publishing houses wake up and realize that the marketplace has drastically changed, they will be left in the dust. Not too long ago my town had a camera store that sold and developed film. That is long gone. I suspect the same will happen soon with bookstores and most of the traditional publishing houses.Â

I think etailers should be free to set their own prices but they shouldn’t be free to go below own cost. Price fixing damages consumers, but pricing below own cost damages competition (and consumers in the long run) because the big etailers like Amazon could easily get rid of all the competition as they enjoy massive investment. Once there is no competition, we all know what happens.